Master Return Measurements for Improved Investment Decision

Aspiring securities professionals taking the FINRA Securities Industry Essentials (SIE) exam must have a robust understanding of return measurements. Key aspects include yield calculations, total return, and basis points, all vital components to making sound investment decisions. In this article, we will break down these concepts, making sure you are well-prepared to tackle related exam questions and real-world scenarios.

Detailed Explanations

Investment Returns and Total Return

Investment Return is a measure of the gain or loss made on an investment relative to the amount of money invested. This return is essential for investors to track the performance of their investments.

Total Return includes not only the capital appreciation on the investment but also any income received from it, such as dividends or interest.

For instance, if you invest $1,000 in a stock and it appreciates to $1,200 over one year while paying a $30 dividend, the total return is the method best to evaluate your outcome:

Yield Calculations

The yield is the income return on an investment, expressed typically as an annual percentage. It’s an important measure as it tells investors how much cash flow they are getting for their investments.

For fixed income securities, such as bonds, yield can take various forms:

• Nominal Yield: Calculated as the coupon rate of the bond.
• Current Yield: This takes the bond’s price into account:

• Yield to Maturity (YTM): This is the total return expected on a bond if it is held until it matures.

Understanding the nuances of each yield type will help identify which option provides the best return relative to cost.

Basis Points

Basis Points are used frequently in financial markets as a way to describe changes in yield or other percentage rates. One basis point is equal to 0.01%, meaning that if a bond’s yield increases from 5% to 5.25%, it has increased by 25 basis points.

Using basis points helps avoid misunderstandings that can occur with percentage increases, so they are essential for clear communication in finance.

graph TD;
    A[Investment Return] -->|includes| B[Capital Appreciation];
    A -->|includes| C[Dividends/Income];
    D[Total Return] --> E[Capital Appreciation] & F[Income Received];
    G[Yield Calculation] -->|types| H[Nominal Yield] & I[Current Yield] & J[Yield to Maturity];

Examples

Scenario 1:
Suppose you hold a bond with a market price of $950 and a coupon payment of $40. Your current yield would be calculated as follows:

Scenario 2:
The Fed announces an interest rate cut of 50 basis points, reducing the rate from 2.5% to 2.0%. Understanding this term helps professionals stay informed and react appropriately to economic announcements.

Summary Points

• Investment Returns encompass both capital gains and income received.
• Total Return gives a comprehensive measure of investment performance.
• Yield calculations help in understanding the return metrics of fixed income instruments.
• Basis Points offer precise measurement changes in interest rates and financial metrics.

Glossary

• Investment Return: The measure of gain or loss on an investment.
• Total Return: A measure of returns considering all income and growth on an investment.
• Nominal Yield: Fixed numerical return on bonds.
• Current Yield: Ratio of annual coupon payment to market price of a bond.
• Yield to Maturity (YTM): The estimated annual return if the bond is held to maturity.
• Basis Points: A unit of measure equal to 1/100th of a percent.

Additional Resources

For further study, consider the following resources:

• “The Essentials of Investing” by Zvi Bodie and Michael J. Clowes
• Investopedia’s Guide to Understanding Yield
• FINRA’s official website for exam updates: finra.org